From time to time, banks may be forced to foreclose upon mortgaged real estate with an active environmental problem. I touched upon this subject back in September of 2009 – Always Consider An Environmental Liability Analysis – but this and next week’s posts provide depth to the topic with the assistance of my colleague Leah Silverthorn, who specializes in environmental law at our Firm.
Some history on environmental law. The Comprehensive Environmental Response Compensation and Liability Act, also is known as “Superfund” (“CERCLA”), enacted in 1980, imposes joint, strict, and several liability for releases of hazardous substances upon four categories of parties: “owners,” “operators,” “transporters,” and “arrangers” (collectively known as potentially responsible parties or “PRPs”). The statute imposes liability simply by virtue of acquiring a contaminated property. In 1986, Congress amended CERCLA through the Superfund Amendments and Reauthorization Act (“SARA”), which, among other things established the innocent landowner exemption, the now rarely-invoked precursor to the 2002 exemptions discussed below.
The exemptions. CERCLA’s goal is the cleanup of contaminated sites, and, as such, it originally contained virtually no legal defenses. Because of this harsh liability scheme, both lenders and developers, as well as local municipalities, raised concerns over the disincentive this statute caused for re-development of “brownfields”—a term given to contaminated (or perceived to be contaminated) real estate. As a result, in 2002, Congress enacted the Small Business Liability Relief and Brownfields Revitalization Act (the “Brownfields Amendment”), adding an exemption to liability for bona fide prospective purchasers (“BFPPs”) and for secured lenders.
BFPP defense. The BFPP defense requires a party (a) to conduct all appropriate inquiries (through a Phase I Assessment), (b) not be related to or associated with another PRP and (c) follow post-closing obligations, including notifications, stopping or preventing future releases or exposure, and cooperating with government requests for access, if necessary. With the enactment of the BFPP exemption, a party can purchase a property with knowledge of environmental conditions and still avoid liability, so long as it takes these steps. (Aside: The BFPP defense does not prevent the United States, if it undertakes remediation itself directly, from placing a senior lien on the real estate. The theory is that the landowner benefitted from such cleanup activities and should not receive a windfall for such benefit. Care should be taken to ensure that the government does not see a need to undertake a cleanup.)
Lender’s exemption, specifically. The Brownfields Amendment also created an exemption for secured lenders (mortgagees), resulting from financial industry worries that foreclosure would automatically transfer liability for all contamination to a foreclosing mortgagee. This exemption comes into play when a mortgagee is forced to foreclose on the property and/or take control of the management of the property. Per CERCLA, lenders typically are exempted from the “owner or operator” definition so long as they “hold indicia of ownership primarily to protect [a] security interest.” The lender must not “participate in management” of environmental decision making and must “seek to sell, re-lease (in the case of a lease-finance transaction)” “at the earliest practicable, commercially reasonable time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements.” A Phase I is not a prerequisite to this exemption.
Good to go, generally. In instances where banks immediately intend to liquidate the mortgaged real estate following the sheriff’s sale, the law is relatively clear—banks generally will be exempt from liability. Since selling the real estate as soon as possible is the modus operendi of virtually all banks and lending institutions, the law provides at least some comfort that conventional banks, in business to enforce their loans through foreclosure and prompt liquidation of their loan collateral, should not be exposed to environmental liability.
Part II, next week, involves the sticky situation when the foreclosing mortgagee decides to retain ownership of the mortgaged real estate.